Adrian & James, Inc. v. Commissioner , 4 T.C. 708 ( 1945 )

Adrian & James, Inc., Petitioner, v. Commissioner of Internal Revenue, Respondent

Adrian & James, Inc. v. Commissioner

Docket No. 685

United States Tax Court

4 T.C. 708; 1945 U.S. Tax Ct. LEXIS 237;

February 2, 1945, Promulgated

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Decision will be entered under Rule 50.

1. In 1925 and during a period from September 29, 1932, to April 21, 1937, petitioner, a personal holding company, purchased gold notes of a transit company with interest coupons attached. Default was made in payment of the notes and the final coupons attached on September 1, 1932, when they all matured, and shortly thereafter the transit company was placed in receivership. After receiving various payments on the indebtedness during the receivership, which payments were derived from interest on the bonds pledged as collateral to the notes and coupons, petitioner sold the notes and the final coupons. Held, that certain parts of those payments constituted a return of capital (by which petitioner's cost basis of the notes and coupons was reduced for the purpose of ascertaining its gain on the sale) and that certain other parts of such payments constituted interest.

2. In March 1937 petitioner paid Federal income tax due for 1936 from a corporation which had been merged into petitioner on December 31, 1936, under an agreement of merger entered into in conformity with a statute of Delaware. Under the agreement and the statute all the debts and liabilities of the predecessor corporation attached to the surviving merged corporation and were enforceable against it. Held, that the amount of income tax of the predecessor corporation paid by petitioner as the surviving corporation should be deducted, under section 406 (a) (1) of the Revenue Act of 1938, from its net income in determining its Title 1A net income for the purpose of determining its dividend carry-over from 1937 to 1939.

3. In computing its dividend carry-over from 1938 to 1939 petitioner is entitled to have the carry-over computed on the basis of its adjusted net income as defined in section 13 (a) of the Revenue Act of 1938.

Elden McFarland, Esq., for the petitioner.

Jonas M. Smith, Esq., for the respondent.

Tyson, Judge.

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TYSON

Respondent determined deficiencies in petitioner's income tax and in personal holding company surtax for the calendar year 1939 in the amounts of $ 2,874.28 and $ 9,813.89, respectively.

The issues are (1) whether the payments, or a portion thereof, received by petitioner with respect to the Interborough Rapid Transit Co. 7 percent gold notes and attached coupons while that company was in receivership, which payments were made out of interest collected on the bonds pledged as collateral thereto, constituted a return of capital rather than interest, for the purpose of ascertaining the cost basis of the notes and coupons in connection with the sale thereof; (2) whether payment by petitioner of the income tax of a corporation which had merged with petitioner is deductible as an income tax of petitioner for the purpose of computing the amount of petitioner's dividend carry-over from 1937 to 1939; (3) whether interest received by petitioner in 1938 on obligations of the United States should be excluded from its adjusted net income for 1938 in computing the amount of petitioner's dividend carry-over from 1938 to 1939.

The proceeding has been submitted on a stipulation of facts and oral evidence adduced at the hearing. Such of the stipulated facts as are not set forth herein are included by reference.

FINDINGS OF FACT.

The petitioner is a Delaware corporation, with its principal office at 40 Journal Square, Jersey City, New Jersey. The returns for the period here involved were filed with the collector for the fifth district of New Jersey.

On October 26, 1925, petitioner purchased $ 10,000 face value of Interborough Rapid Transit Co. (hereinafter sometimes called Transit Co.) 7 percent gold notes at a cost of $ 9,100.63. Each note was of the face value of $ 1,000. At the time of the purchase final interest coupon No. 20, in the face amount of $ 35, as well as other coupons, was attached to each of said notes. The maturity date of the notes was September 1, 1932. The due date of coupon No. 20 was September 1, 1932.

On September 1, 1932, the obligor, Transit Co., defaulted in the payment of the principal of the notes and in the payment of the final interest coupons No. 20 attached thereto. No prior default in payment of interest or principal had occurred.

Subsequent to the foregoing default, and during the period from September 29, 1932, to April 21, 1937, petitioner acquired additional 7 percent gold notes of the Transit Co. of the same character in the total face amount of $ 38,000, at a total cost of $ 24,910. Final interest coupon No. 20 in the face amount of $ 35 was attached to each of said notes. These notes and coupons were acquired on the dates, in the amounts, and at the cost below tabulated:

Face value	Date
of notes	acquired	Cost
$ 4,000	9/29/32	$ 2,410.00
3,000	10/ 1/32	1,807.50
10,000	10/19/32	5,862.50
2,000	11/ 3/32	1,095.00
2,000	8/23/33	1,385.00
$ 2,000	11/10/33	$ 1,235.00
1,000	11/10/33	622.50
3,000	11/13/33	1,867.50
2,000	11/14/33	1,245.00
2,000	11/15/33	1,245.00
$ 5,000	12/26/35	$ 4,600.00
2,000	4/21/37	1,535.00
38,000		24,910.00

All the Transit Co. 7 percent gold notes purchased by petitioner were issued as of September 1, 1922, to mature in 10 years. There were originally attached to each $ 1,000 note 20 interest coupons of $ 35 each, maturing in successive semiannual periods; that is to say, the first coupon covered interest on the principal of the note to which it was attached for the first 6 months and each successively numbered coupon covered such interest for a later 6-month period.

Shortly after September 1, 1932, the obligor on the notes was placed in receivership in the United States District Court for the Southern District of New York. A receiver was duly appointed by the court, and the Bankers Trust Co., trustee under the collateral indenture of the Transit Co. dated September 1, 1922, continued to act as such trustee.

On December 3, 1935, the court issued an order in that proceeding reciting that the trustee had petitioned "for instructions as to the proper distribution and allocation of monies received and to be received by said Trustee from the Receiver herein as interest upon Bonds pledged as collateral under said Indenture." The court then "Found, Ordered, Adjudged and Decreed" that the Bankers Trust Co., as trustee, and the holders and owners of the secured 7 percent gold notes and coupons of the Transit Co. had a valid claim against that company "for the principal amount of said Notes and for interest upon said Notes and upon all of said interest coupons from and after their respective maturities." The order provided further that "So far as such claim is for interest, it accrues at the rate of seven (7%) per cent. per annum." The order further provided that:

3. The holder or registered owner of each Note or coupon is entitled to share in each distribution of collateral, its income and its proceeds, on the basis of the face amount of such Note or coupon with interest thereon from maturity at the rate of seven (7%) per cent. per annum.

4. The pro rata participation of the holders of coupons matured prior to September 1, 1932, in each distribution should include simple interest thereon from their respective maturities to the date of such distribution, so far as the same has not theretofore been paid.

5. The monies received and to be received by Bankers Trust Company, as Trustee, from the Receiver herein should be allocated first to interest upon all of the Notes and coupons accrued from their respective maturities to the date of any distribution, and then in reduction of the principal amounts of the Notes and coupons pro rata between the principal amount of each Note and coupon * * *.

The order instructed the trustee to allocate on its records any distributions theretofore or thereafter made as against the obligor, Transit Co., and as between the respective holders and owners of the notes and coupons, "upon the principles hereinabove set forth" and illustrated by a schedule detailing the amount and application of each semiannual distribution beginning January 1, 1933, to and including July 1, 1935. A typical excerpt from the schedule is as follows:

			Final
		Principal	coupon	Total
		of note	(#20)
September 1, 1932, there became due		$ 1,000.00	$ 35.00	$ 1,035.00
January 1, 1933:
	Post-due interest -- 4 mos. at 7%	23.33	.82	24.15
	Total amount due January 1, 1933	1,023.33	35.82	1,059.15
First distribution, $ 41.40:
	Applicable to post-due interest	23.33	.82	24.15
	Applicable to principal	16.67	.58	17.25
	Total distribution	40.00	1.40	41.40
Balance after distribution		983.33	34.42	1,017.75
July 1, 1933:
	Post-due interest -- 6 mos. at 7% on balance	34.42	1.20	35.62
	Total amount due July 1, 1933	1,017.75	35.62	1,053.37
Second distribution, $ 44.00:
	Applicable to post-due interest	34.42	1.20	35.62
	Applicable to principal	8.09	.29	8.38
	Total distribution	42.51	1.49	44.00
Balance after distribution		975.24	34.13	1,009.37

The schedule concluded with the following tabulation:

Total distributions through July 1, 1935	$ 257.90
Account principal of note	56.55
Account principal of final coupon	1.97
Account post-due interest	199.38
	257.90

The order further provided:

2. In making distribution on or after January 1, 1936, of monies, if any, received or held by Bankers Trust Company, as Trustee, representing interest upon the pledged Bonds, there shall first be paid to the holders of coupons maturing prior to September 1, 1932, a sum representing simple interest upon the face amount of such coupons from their respective maturity dates to September 1, 1932, in such amount that after the distribution as of January 1, 1936, such coupons will be entitled to receive further distributions upon the same basis as those matured September 1, 1932, and the balance, if any, in the hands of Bankers Trust Company, as Trustee, shall be distributed and allocated as herein directed; and it is further

Ordered, Adjudged and Decreed that the allocations hereinabove directed shall be final and binding upon the defendant, Interborough Rapid Transit Company, upon its Receiver, upon Bankers Trust Company, as Trustee, and upon all and singular the holders and registered owners of Notes and coupons; and distributions made and to be made by Bankers Trust Company, as Trustee, in accordance herewith, shall satisfy and discharge its claim and the claims of the holders and registered owners of Notes and coupons against Interborough Rapid Transit Company and its receivership estate pro tanto.

This order was never appealed, modified, or revoked, and the court issuing the order has and had exclusive jurisdiction in the matter of the receivership, including settlement of all claims of creditors and payment in whole or in part of such claims.

Beginning January 1, 1933, through January 1, 1939, the trustee made 13 semiannual distributions to the holders of the notes, including the petitioner, allocating such payments between the principal of the notes, principal of final coupons No. 20, "post-due interest" on the notes, and "post-due interest" on final coupons No. 20. The total of the 13 distributions was allocated on each $ 1,000 note and final coupon No. 20 for $ 35 as follows:

Account principal of note	$ 124.01
Account principal of prior coupon	4.31
Account post-due interest	431.58
	559.90

This distribution was in accordance with the court order applicable thereto.

With each payment made to petitioner, the trustee enclosed a notice showing the amount of the payment applicable to principal of the note, to "post-due interest" on such principal, to principal of coupon No. 20, and to "post-due interest" on the principal of such coupon. At the head of the notice appeared the following statement:

Accrual of post-due interest, and allocation of the several distributions made by Bankers Trust Company, Trustee, in accordance with the general principles established by Federal Judge Mack in his order, dated December 3, 1935, in the I. R. T. Receivership proceedings.

Upon receipt of such payments the petitioner entered them on its books of account and allocated them as between principal and interest in the same manner as allocated in the notices received by it from the trustee, except as to amounts received in respect of interest coupons No. 20. All of the amounts it received in respect to coupons No. 20 attached to the $ 10,000 face value of notes acquired prior to the default of September 1, 1932, petitioner entered on its books of account as interest; and of those amounts which it received in respect of such interest coupons No. 20 attached to the $ 38,000 face value notes which it acquired subsequent to the default, it entered on its books of account as interest those amounts which were designated by the trustee's notice as "applicable to post-due interest"; and it entered as return of principal those amounts designated by the trustee's notice as "applicable to principal."

Petitioner kept its books of account and filed its returns on a cash receipts and disbursements basis. In filing its income tax returns it followed the allocations shown on its books of account.

On October 4, 1939, petitioner sold the $ 48,000 face value notes for a total consideration of $ 32,880.

In determining the basis for computing its profit on the sale of the notes petitioner allocated a portion of the payments it had received from the trustee as interest and allocated a portion thereof as payments of principal received, making such allocation in conformity with its books of account. It thus reduced its total original cost of the notes from $ 34,010.63 to $ 28,624.83, being a reduction of $ 5,385.80, which was the amount it allocated as payment on and return of principal. Petitioner thus computed an adjusted cost basis for the notes of $ 28,624.83, which basis it used in reporting a resulting gain of $ 4,255.17 in its income tax return for 1939.

The respondent, however, in determining the amount of gain realized in 1939 by petitioner on the sale of the notes with final coupons No. 20 attached, treated the total amounts of all distributive payments received by petitioner prior to the sale as being payments of principal, and consequently, as reductions of cost basis, with a resulting increase of $ 17,040.70 of taxable gain.

The total authorized and originally issued face amount of the Transit Co.'s 7 percent gold notes here involved was $ 34,330,000. At the date of default thereon, $ 31,672,100 face value thereof was outstanding. The issue was secured by pledge of $ 54,989,000 face value first and refunding mortgage 5 percent notes of the same obligor. Distributions made by the trustee and received by the petitioner were from funds received by the trustee as interest on the pledged collateral.

The 7 percent gold notes with such coupons as were attached were listed on the New York Stock Exchange and the price ranges thereof for the years 1932 to 1939, inclusive, were as follows:

1932	79 1/4-43 1/2
1933	75 3/8-51 1/2
1934	88    -70 1/4
1935	97    -84
1936	97    -90
1937	91 1/2-49 1/2
1938	69 1/4-40
1939	74    -50

The average cost to petitioner of its 7 percent gold notes, with such coupons as were attached, was a little less than 68 1/2.

Petitioner was informed of the fact that the 7 percent gold notes and interest coupons No. 20 attached thereto were in default when it acquired $ 38,000 face value thereof subsequent to the default date and after September 1, 1932.

Petitioner was incorporated under the General Corporation Law of the State of Delaware on May 14, 1928. The Acee Corporation was so incorporated on May 11, 1928. These two corporations were merged pursuant to an agreement of merger dated December 31, 1936, duly ratified by the directors and shareholders thereof, and filed and recorded with the Secretary of State of the State of Delaware, the same date, pursuant to section 59 of the General Corporation Law of the state.

The agreement of merger provided in part:

* * * it is hereby agreed by and between the said parties hereto, and in accordance with Section 59 of the General Corporation Law of the State of Delaware, that said Adrian & James, Inc. and said Acee Corporation shall be, and they are hereby, merged into Adrian & James, Inc. and shall hereafter be a single Corporation which shall be Adrian & James, Inc. which is and shall be the surviving corporation * * *

* * * *

Twelfth: When this Agreement shall have been signed, acknowledged, filed and recorded, as required by Section 59 of the General Corporation Law of the State of Delaware, the separate existence of Acee Corporation shall cease and said corporation shall be merged into Adrian & James, Inc., which shall continue in existence and shall possess all the rights, privileges, powers and franchises as well of a public as of a private nature and shall be subject to all the restrictions, disabilities and duties of said corporation so merged and all and singular the rights, privileges, powers and franchises of said corporation and all property, real, personal and mixed and all debts due to said corporation on whatever account as well for stock subscriptions as all other things in action or belonging to said corporation shall be vested in Adrian & James, Inc., the Merged Corporation; and all property, rights, privileges, powers and franchises and all and every other interest shall be thereafter as effectually the property of the Merged Corporation as they were of Acee Corporation, and the title to any real estate, whether by deed or otherwise, under the laws of the State of Delaware vested in said corporation shall not revert or be in any way impaired by reason of this merger; provided that all rights of creditors and all liens upon the property of said corporation shall be preserved unimpaired, and all debts, liabilities and duties of said corporation shall thenceforth attach to said Merged Corporation, and may be enforced against it to the same extent as if said debts, liabilities and duties had been incurred or contracted by it.

The Acee Corporation's Federal income tax liability for the year 1936 was $ 3,911.13, which tax was paid by petitioner by check dated March 12, 1937. The amount of this payment was not deducted by respondent in his computation of the amount of petitioner's dividend carry-over from the year 1937 to the year 1939.

During the years 1937, 1938, and 1939 the petitioner declared and paid as dividends to its shareholders the following amounts:

1937	$ 76,800.00
1938	57,246.75
1939	75,000.00

During the years 1937 to 1939, inclusive, petitioner received interest on certain obligations of the United States, required to be included in gross income under the revenue acts in effect for those years, in the following amounts:

1937	$ 6,086.25
1938	14,463.37
1939	14,922.22

In determining petitioner's dividends paid credit for the purpose of arriving at the dividend carry-over from 1938 to 1939 in computing petitioner's personal holding company surtax for 1938, the respondent reduced the dividends paid by petitioner during 1938 ($ 57,246.75) by the amount of $ 14,463.37 received in 1938 as interest on obligations of the United States.

OPINION.

The first issue is whether the payments, or any portion thereof, received by the petitioner with respect to the Transit Co. 7 percent gold notes and attached coupons while the Transit Co. was in receivership, which payments were made out of interest collected on the bonds pledged as collateral thereto, constituted a return of capital rather than interest for the purpose of ascertaining the cost basis of such notes and coupons in connection with their sale in 1939. Respondent contends that the notes and coupons when acquired were acquired as one single piece of property and that all subsequent payments received thereon, including "post-due interest," were a return of capital, so that petitioner's cost basis for the purpose of determining its gain on the subsequent sale of such notes and coupons must be correspondingly reduced by the full amount of such payments, citing Pierce Corporation v. Commissioner, 120 Fed. (2d) 206; Erskine Hewitt, 30 B. T. A. 962, 965; William H. Noll, 43 B. T. A. 496, 502; and R. O. Holton & Co., 44 B. T. A. 202, 205. It is clear that the payments received on the principal of the notes, whether those notes were acquired prior or subsequent to default, constitute a return of capital. Cf. William H. Noll, supra, and R. O. Holton & Co., supra, and authorities cited therein. It is equally clear that under the authority of Pierce Corporation, supra,Erskine Hewitt, supra,William H. Noll, supra, and R. O. Holton & Co., supra, the payments received after default on the principal of the coupons acquired subsequent to default and attached to the $ 38,000 of notes also constitute a return of capital. However, the payments received after default on the principal of the coupons attached to the $ 10,000 face value notes purchased long prior to default of the coupons constitute, in our opinion, interest rather than a return of capital, because no portion of the principal amount of such interest coupons had been earned or accrued prior to their acquisition by petitioner, that acquisition having been in 1925 and no part of the principal or the interest coupons having been earned or accrued prior to 1932. As to the final coupons attached to these $ 10,000 notes it may be said, as in Erskine Hewitt, supra, that "In such a case there is of course no purchase of defaulted interest and in subsequent years if there is a default in interest which is subsequently paid it is income to the owner of the bonds (notes here) in the year in which it is paid." Cf. Landon v. Commissioner, 59 Fed. (2d) 989.

This brings us to consideration of another question presented by the first issue, i. e., whether payments received by petitioner from the trustee and designated by the court and trustee as "post-due interest" on the principal of the notes and on the principal of the coupons, including those purchased prior to and subsequent to default, constitute interest or a return of capital. This question was not considered or decided in any of the cases cited by respondent. We are of the opinion that such payments of "post-due interest" on the notes and coupons, whether acquired prior or subsequent to default, constitute interest and not a return of capital to the extent that it was earned or accrued after the notes and coupons were acquired. Since the $ 10,000 notes and coupons were acquired in 1925, long before the "post-due interest" on the notes and coupons began to accrue on September 1, 1932, manifestly, none of the "post-due interest" paid and received on such notes and coupons had been earned or accrued at their acquisition, and consequently the entire amount so paid and received is interest and not a return of capital.

As to the $ 38,000 notes and coupons acquired after default, the record shows they were acquired at various dates after September 1, 1932, when the "post-due interest" began to accrue. It is apparent from the schedule of payments of "post-due interest" on the notes and coupons and the dates of acquisition of such notes and coupons that when these notes and coupons were acquired after default some portion of the interest designated as "post-due interest" had been earned or accrued and when this portion was subsequently paid to petitioner it constituted a return of capital. That portion was not income from petitioner's investment because it was earned or being accrued prior to such investment and constituted a part of that investment. See Helvering v. Missouri State Life Ins. Co., 78 Fed. (2d) 778; L. A. Thompson Scenic Railway Co., 9 B. T. A. 1203; Great Southern Life Insurance Co., 33 B. T. A. 512; affd., 89 Fed. (2d) 54; certiorari denied, 302 U.S. 698">302 U.S. 698; and Great Southern Life Insurance Co., 36 B. T. A. 828. The portion of interest included in the designation of "post-due interest" which had been earned or accrued on the $ 38,000 notes and attached coupons at the date of their acquisition is subject to mathematical determination from the schedule showing the dates and amounts of such interest payments and the tabulation in our findings showing the dates on which the notes and coupons were acquired.

The second issue involves the determination of the amount of petitioner's dividend carry-over from 1937 to 1939. The original income tax liability of the Acee Corporation for the year 1936 was $ 3,911.13, which amount the petitioner paid in March 1937. Prior thereto, on December 31, 1936, the Acee Corporation and petitioner had executed, acknowledged, filed, and recorded with the Secretary of State of Delaware an agreement of merger whereby:

* * * in accordance with Section 59 of the General Corporation Law of the State of Delaware, * * * said Adrian & James, Inc. and said Acee Corporation shall be, and they are hereby, merged into Adrian & James, Inc. and shall hereafter be a single Corporation which shall be Adrian & James, Inc. which is and shall be the surviving corporation * * *

The agreement provided that all debts, liabilities, and duties of the Acee Corporation attached to the petitioner as the surviving merged corporation and were enforceable against it, as such, to the same extent as if incurred or contracted by it. This latter and the other provisions of the agreement of merger were in conformity with the General Corporation Law of the State of Delaware. Those laws, found in the Revised Code of Delaware 1935, ch. 65, art. 1, after providing in section 59 for an agreement of merger, such as that here, further provided, in section 60 thereof, as follows:

When an agreement shall have been signed, acknowledged, filed and recorded, as in the preceding Section is required, for all purposes of the laws of this State the separate existence of all the constituent corporations, parties to said agreement, or of all such constituent corporations except the one into which the other or others of such constituent corporations have been merged, as the case may be, shall cease and the constituent corporations shall become a new corporation, or be merged into one of such corporations, as the case may be, in accordance with the provisions of said agreement, * * * and being subject to all the * * * duties of each of such corporations so consolidated or merged, * * * provided, however, that all rights of creditors and all liens upon any property of said constituent corporations shall be preserved unimpaired, and all debts, liabilities and duties of the respective constituent corporations shall thenceforth attach to said resulting or surviving corporation, and may be enforced against it to the same extent as if said debts, liabilities and duties had been incurred or contracted by it.

Petitioner, having paid the original income tax liability of the Acee Corporation after the merger, now contends that the amount of such payment should have been deducted from its net income in computing its 1937 Title 1A net income, as a personal holding company, for the purpose of determining its dividend carry-over from 1937 to 1939. It relies specifically on the language of section 406 of the Revenue Act of 1938 (now, in substance, section 505 (a) (1), Internal Revenue Code as enacted in 1939), providing in part, as follows:

SEC. 406. TITLE 1A NET INCOME.

For the purposes of this title the term "Title 1A net income" means the net income with the following adjustments:

(a) Additional Deductions. -- There shall be allowed as deductions --

(1) Federal income, war-profits, and excess-profits taxes paid or accrued during the taxable year to the extent not allowed as a deduction under section 23; * * *

The sole contention made by respondent on this second issue is that the additional deductions allowed by section 406 (a) (1) of the Revenue Act of 1938 (now, in substance, section 505 (a) (1), Revenue Code as operative in 1939) are applicable only to Federal income taxes paid by a taxpayer in discharge of a liability for its own income taxes and not in discharge of a liability for such taxes of another corporation; and that when petitioner paid the income tax of Acee Corporation for 1936 it was paying that tax as an assumed debt and not as an income "tax liability" of its own, citing New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435, and Jones v. Noble Drilling Co., 135 Fed. (2d) 721. We think this contention of respondent is completely foreclosed by our holding in Alaska Salmon Co., 39 B. T. A. 455, wherein we held in the case of a merger of a Washington corporation into a California corporation that "the tax liability" of the Washington corporation became "the tax liability" of the California corporation, applying the same rule as was applied in Bowman Hotel Corporation, 24 B. T. A. 1193, and Trahern Pump Co., 27 B. T. A. 363, with regard to consolidated corporations. The Delaware statute here considered is, in effect, the same as the Washington and California statutes as considered together in the Alaska Salmon Co. case.

The authorities cited by respondent do not support his contention and are not contrary to the holding in the Alaska Salmon Co. case.

The New Colonial Co. case is clearly distinguishable from the instant case, among other respects, in that there a deduction for a loss was sought by a new corporation which had acquired, through an exchange of its stock, the assets, liabilities, and business of an old corporation, which loss had been sustained by the old corporation prior to the transfer. The old corporation, although transacting no business after the transfer, remained in existence throughout the years for which the new corporation claimed the deduction. That case involved no question, as is here, of whether under a statutory merger the payment by the surviving corporation of Federal income taxes due from a merged corporation was payment of a tax liability of the surviving corporation and consequently deductible by it. That case is further distinguishable here, as was done in New York Cent. R. Co. v. Commissioner, 79 Fed. (2d) 247; certiorari denied, 296 U.S. 653">296 U.S. 653, where it was held that a loss on bond discount on bonds sold by a predecessor corporation which had been consolidated with other corporations to form a new corporation was not a loss of the predecessor corporation, but was a loss of and deductible by the new corporation because where the bonds were matured and paid by the new corporation that corporation would sustain the loss occasioned by the bond discount. The court, with reference to the Commissioner's contention that allowable deductions are personal to the taxpayer and could not be transferred to or be used by another corporation, distinguished the New Colonial Co. and other cases cited in support of that contention by saying:

The Commissioner argues that allowable deductions are personal to the taxpayer and cannot be transferred to or used by another. But the cases which announce this doctrine deal with losses sustained by a predecessor and sought to be deducted by a successor. * * * In the case at bar, no loss was sustained by the issuing corporations in selling their bonds at a discount; the loss will be sustained by the consolidated corporation when the bonds mature and are paid. Hence the deductions here in question are by way of anticipation of the taxpayer's own loss and should have been allowed.

Here, the income tax of the Acee Corporation for 1936 claimed by petitioner to be deductible by it was paid by petitioner as the surviving corporation and not by Acee Corporation.

In the Jones v. Noble Drilling Co. case the sole question was whether a surviving corporation into which three predecessor corporations had been merged was entitled to claim a dividend paid credit carry-over. The claimed credit was in respect to dividends paid by one of the predecessor corporations and the credit could have been claimed by that corporation had it continued to exist as a separate and distinct corporation after the merger. The court held that the surviving corporation was not entitled to the credit because the predecessor had itself paid the dividends sought to be claimed as a dividend carry-over by the surviving corporation, and the right to a deduction for such carry-over was in the predecessor and was not transferable to the surviving corporation. Here, the petitioner itself paid the dividends sought to be claimed as a carry-over and the case is distinguishable in this vital respect, if none other, from the Noble case. The principle of this distinction was recognized by the Noble case itself in distinguishing the case of Helvering v. Metropolitan Edison Co., 306 U.S. 522">306 U.S. 522, wherein a corporation taxpayer, the survivor in a merger, had acquired the assets and assumed the liabilities of a subsidiary corporation which had issued bonds at a discount. The question presented in the Metropolitan Edison case was whether the taxpayer could deduct the unamortized bond discount on the bonds paid by it. The question was decided in favor of the taxpayer, and in distinguishing that case from its own holding the court in the Noble case said, inter alia: "In that case, the corporate taxpayer sought the deduction of deferred interest paid by it. In the instant case, the surviving corporation seeks to avail itself of a deduction of dividends paid by another corporation."

As to the second issue we hold that the amount of the Federal income tax of the Acee Corporation for 1936 paid by petitioner in 1937 was paid on petitioner's tax liability and is deductible from its net income in computing its Title 1A net income for the purpose of determining its dividend carry-over from 1937 to 1939.

The third issue involves the proper method of computing the petitioner's dividends paid credit for the purpose of ascertaining the amount of its net income subject to personal holding company surtax for the year 1939. The error particularized on brief by the petitioner is that "in computing the dividend carry over from 1938 to 1939, [the respondent] reduced the dividends paid credit for 1938 by $ 14,463.37 interest on obligations of the United States," contrary to the provisions of section 405 (a) of the Revenue Act of 1938.

The statute controlling the surtax of personal holding companies for the year 1939 is subchapter A of chapter 2 of the Internal Revenue Code as enacted in 1939. Section 505 of the code defines what is called "Subchapter A Net Income" as the net income with certain specified adjustments relating to deductions. Section 500 of the code imposes the surtax upon the "undistributed subchapter A net income," which is defined in section 504 as follows:

For the purposes of this subchapter the term "undistributed subchapter A net income" means that subchapter A net income (as defined in section 505) minus --

(a) The amount of the dividends paid credit provided in section 27 (a) * * * (computed without its reduction, under section 27 (b) (1), by the amount of the credit provided in section 26 (a), relating to interest on certain obligations of the United States * * *).

The dividends paid credit provided in section 27 (a) of the code, in so far as this case is concerned, with respect to any taxable year, is the sum of:

(1) The basic surtax credit for such year, computed as provided in subsection (b);

(2) The dividend carry-over to such year, computed as provided in subsection (c).

The pertinent provisions of section 27 (c) respecting the dividend carry-over are as follows:

(c) Dividend Carry-Over. -- There shall be computed with respect to each taxable year of a corporation a dividend carry-over to such year from the two preceding taxable years, which shall consist of the sum of --

(1) * * *; and

(2) The amount, if any, by which the basic surtax credit for the first preceding taxable year exceeds the adjusted net income for such year.

In the case of a preceding taxable year, referred to in this subsection, which begins in 1937, the adjusted net income shall be the adjusted net income as defined in section 14 of the Revenue Act of 1936, and the basic surtax credit shall be only the dividends paid credit computed under the Revenue Act of 1936 without the benefit of the dividend carry-over provided in section 27 (b) of such Act. In the case of a preceding taxable year, referred to in this subsection, which begins in 1938, the adjusted net income shall be the adjusted net income as defined in section 13 (a) of the Revenue Act of 1938, * * * and the basic surtax credit shall be the basic surtax credit as defined in section 27 of the Revenue Act of 1938, * * *

The determination of the dividend carry-over from 1938 to 1939, therefore involves computations of the petitioner's basic surtax credit for 1938 and of its adjusted net income for 1938, both computations to be made pursuant to provisions of the Revenue Act of 1938. Section 27 (b) (1) of the 1938 Act states that the "basic surtax credit" includes, among other elements, "the dividends paid during the taxable year, * * * reduced by the amount of the credit provided in section 26 (a), relating to interest on certain obligations of the United States," and, as section 504 of the code as enacted in 1939 provides that the amount of the dividends paid credit provided in section 27 (a) must be computed "without its reduction, under section 27 (b) (1)" by the amount of the credit so provided in section 26 (a), the intent is plain that the basic surtax credit of a personal holding company is not to be reduced by interest received on United States obligations. The respondent, in computing the dividend carry-over from 1938 to 1939, reduced dividends paid during 1938 by interest received on United States obligations in the amount of $ 14,463.37, contrary to section 504, supra. This he concedes.

The real difference between the parties arises over whether the petitioner's adjusted net income for the preceding year 1938, to be used in computing the dividend carry-over, is to be reduced by such interest. In computing the dividend carry-over from 1938 to 1939, the respondent used the figure of $ 39,241.48 as representing the adjusted net income for 1938. That amount is the petitioner's net income for 1938 after excluding $ 14,463.37 interest received on obligations of the United States. He now contends that he should not have deducted such interest in computing the adjusted net income for 1938; that the adjusted net income to be used in the computation is its total net income of $ 53,704.85 ($ 39,241.48 plus $ 14,463.37); and that when the latter amount is subtracted from the $ 57,246.75 of dividends paid in 1938, the resulting dividend carry-over from 1938 is $ 3,541.90 -- the same amount which he allowed in his notice of deficiency.

The contention is made in the face of the positive direction of 27 (c) of the Code of 1939 that in the case of a preceding taxable year which begins in 1938 the adjusted net income "shall be the adjusted net income as defined in section 13 (a) of the Revenue Act of 1938" (emphasis supplied), and in the face of the provision of section 13 (a), that the term "adjusted net income" means "the net income minus the credit provided in section 26 (a), relating to interest on certain obligations of the United States." The respondent asks us to say that this language does not mean what it says in such plain terms, but that it means "the personal holding company adjusted net income (Title 1A net income in 1938) which amount is computed without reduction of interest on obligations of the United States." This we can not do. As a matter of fact the respondent has given the same effect as we do to the positive terms of the statute in his own regulations under the Code of 1930. Thus, in section 19.27 (c)-1, Regulations 103, he states: "In computing the dividend carry-over the adjusted net income for a preceding taxable year which begins in 1938 shall be the adjusted net income as defined in section 13 (a) of the Revenue of 1938." (Emphasis supplied.)

We are of the opinion that the petitioner in computing its dividends paid credit is entitled to have its dividend carry-over from 1938 to 1939 computed on the basis of its adjusted net income as defined in section 13 (a) of the Revenue Act of 1938; that is, its net income minus the credit for the interest of $ 14,463.37 received by it on obligations of the United States, and we so hold.

Decision will be entered under Rule 50.